Why We Care About the Price of Water in China: Peter Orszag

July 6 (Bloomberg) -- An American trucker barreling down
Interstate 95 bemoaning the high price of diesel fuel might
never imagine that one of the things driving up his bill is the
way water in China is being mispriced. But the truth is, water
shortages are indirectly causing increased use of diesel
generators for electricity in China, and that, in turn, is
helping raise diesel prices in the U.S.

Smarter pricing could help China -- and the rest of the
world -- avoid further problems allocating water resources, and
mitigate some of the side effects.

Coal plants generate most of China’s electricity.
Hydropower is the second-biggest source. Water is clearly
essential for hydropower, but a lot of it is needed for coal
power, too -- to mine the raw material, to process it and then
to cool the power plants that burn it. In 2010, coal-fired
electricity in China used more than 30 trillion gallons (114
trillion liters) of water, or about 20 percent of the country’s
total consumption. And over the coming decade, roughly 40
percent of the nation’s increase in water demand will be
associated with coal power, China’s Ministry of Water Resources
says.

This development is exacerbating an already severe shortage
in China. The country accounts for about 15 percent of the
world’s consumption of fresh water. Yet its supplies are
limited, and pollution is a significant hazard.

According to the World Bank, the amount of water per capita
in China is only one-quarter of the global average. Furthermore,
about 80 percent of the total supply is south of the Yangtze
River, while only about half the Chinese population lives there.
So the north is chronically short. The North China plain, which
encompasses both Shanghai and Beijing, contains more than 40
percent of the national population, but less than 15 percent of
the water. In this region, the per-capita amount is only about
one-quarter the level considered the minimum for people to live
on.

Pollution Hurts

Widespread pollution exacerbates the situation. About 90
percent of the aquifers underneath major cities in China are
polluted. More than 300 million Chinese lack access to safe
drinking water, according to the World Bank.

In addition to these challenges, there is a severe drought
this year, which is the worst in half a century, according to
some estimates. Rainfall is 40 percent to 60 percent lower than
normal, which means less power from hydroelectric dams and too
little water to support some coal-fired plants. The Chinese
have, therefore, had to lean more heavily on diesel generators
to help power the electricity grid. That, in turn, has led
officials to ban exports of diesel fuel.

And that raises costs for the trucker on I-95.

So what can be done? Broadly, three things.

The first is to reduce China’s water pollution and,
globally, address the threat of climate change. Some scientists
say climate change is already increasing the pressure on China’s
water supply by disrupting normal patterns of rain- and
snowfall.

The second is to increase the supply of usable water in the
places in China that lack it, through desalination and by
redirecting water from south to north. In the Tianjin-Binhai
development zone, on the western shore of the Bohai Sea, China
has built a 12 billion-yuan ($1.9 billion) desalination plant,
using the latest Israeli technology. In addition, the nation is
embarking on the world’s largest water-diversion project, to re-route part of the Yangtze along three channels to the north.

Raise the Price

But what is perhaps most promising is the third solution:
better pricing of existing water resources. Water is Earth’s
most valuable commodity, and yet in most countries it is given
away free -- as if it had no value at all.

In Oman, a Middle Eastern desert country where water is
scarce, it is understood to be more valuable. There, farmers
trade water rights. As Peter Brabeck-Letmathe, the chairman of
Nestle SA, has pointed out, farmers are in the best possible
position to know water’s value. Pricing it through tradable
rights or other mechanisms “is an extremely strong incentive to
use water efficiently,” Brabeck-Letmathe said in an interview
with the McKinsey Quarterly.

The academic literature bears out his point. In a July 2007
study, Sheila Olmstead of Yale University and Robert Stavins of
Harvard University concluded that using prices to manage water
demand was more cost-effective than conservation programs not
linked to price, such as restrictions on watering the lawn and
subsidies for low-flow faucets.

Yet many critics of higher prices for water say low- and
moderate-income households will be unfairly affected. So the
most promising way to price water -- in China as well as in the
U.S. and elsewhere -- would be to provide, at no cost, a base
amount per day for normal activities, such as cooking and
cleaning, and then charge for water used above that threshold at
rates that rise with the increased amount consumed.

The Chinese people are willing to pay more for water, the
World Bank reports, “as long as the quality of the service is
good and the tariff level acceptable.” And yet prices in China
are still much too low to ensure that the water is used
efficiently enough to sustain the supply. Higher prices would
persuade people to both reduce waste and improve the allocation
of water across all its possible uses (including in the energy
sector). It would also encourage more investment in desalination
and other measures to increase supply.

If China moved more aggressively to price water in a manner
that reflected demand and supply, it could teach the U.S. a
lesson in using market economics to address environmental
issues. As a colleague of mine at Citigroup Inc., the analyst
Deane Dray, has written, “water has never been priced
efficiently.” In the U.S., water is generally heavily
subsidized, and prices aren’t adequately linked to usage levels.

Just as we need to price carbon in order to avoid a climate
crisis, we need to price water to avoid a water crisis. Market
forces can work wonders for the environment, but only if we have
the political courage to create them.

(Peter Orszag, vice chairman of global banking at Citigroup and
a former director of the Office of Management and Budget in the
Obama administration, is a Bloomberg View columnist. The
opinions expressed are his own.)